It is becoming increasingly clear that the first U.S. interest rate cut is just around the corner. The next Federal Open Market Committee (FOMC) meeting, scheduled for September 18, will determine the Federal Reserve’s (FED) next move on U.S. Dollar interest rates.

The FED has strongly indicated its intent to reduce rates by at least 25 basis points, with a slim possibility of a 50 basis point cut, although this is highly unlikely following the release of a slightly higher-than-expected U.S. Consumer Price Index (CPI) yesterday. At present, the market assigns an 87% probability to a 25 basis point reduction, with only a 13% chance of a 50 basis point cut.

The U.S. interest rate is particularly significant for the crypto market, as it directly influences investors’ willingness to take risks in pursuit of returns. Central bank rates, including those set by the FED, establish the baseline for what investors expect as a minimum return, essentially the closest thing to a risk-free return. If the FED’s rate is 5%, very few would consider investing in digital assets unless they expect returns significantly higher than 5%, given the much greater risks involved with crypto.

Looking at our Principal Component Analysis (PCA) model, it is clear that rising global yields have a negative impact on Bitcoin and Ethereum prices. Every time these yields increase, Bitcoin and Ethereum tend to fall. However, we must also acknowledge that interest rates are embedded in many other market factors, such as U.S. equity performance and corporate credit risk. The lower the interest rates, the better these factors tend to perform, which in turn benefits Bitcoin, Ethereum, and the broader crypto market.

Chart 1: Bitcoin and Ethereum Macroeconomic Basket Sensitivity

When reviewing U.S. Dollar and Euro interest rates over the past six years, we see that the FED initiated its most recent rate-cutting cycle in 2019, less than a year before the COVID-19 pandemic hit. In response to corona, the FED drastically lowered rates to near-zero in March 2020. This chart also highlights the significant rate hikes undertaken by both the FED and the European Central Bank (ECB) in early 2022 to combat rising inflation, as well as the two 25 basis point cuts made by the ECB this year, one of which occurred today.

Chart 2: Bitcoin & Ethereum Prices vs. USD & EUR Interest Rates